David Stockman, Budget Director under President Reagan, then a partner at private-equity firm Blackstone Group, and now bestselling author, graciously gave me permission to post the particularly relevant and prescient Chapter 23 of his book, The Great Deformation: The Corruption of Capitalism in America.
The Fed’s frenetic interest rate cutting and renewed commitment to the Greenspan Put after December 2000 generated another spree of financial engineering. In all three variations, buybacks, buyouts, and M&A takeovers, the common effect was equity extraction from the business sector. However, unlike the case of mortgage equity withdrawal by households, where the cash windfall was distributed widely across the middle class, corporate equity withdrawal resulted mainly in cash distributions to the very top of the economic ladder. In generating a cornucopia of CEW, therefore, financial engineering functioned as the ATM of the prosperous classes.
That CEW went overwhelmingly to the bank accounts of the wealthy is a balance sheet given. By the end of the first Greenspan bubble, about 80 percent of financial assets were owned by the top 10 percent of households, which therefore got at least 80 percent of the cash from buyouts and buybacks. In fact, far more than a proportionate share went to the top, and even then the windfall was not so egalitarian in the manner in which it was whacked up among the affluent classes. Among the 10 percent at the top, it was the 1 percent at the very top who got the lion’s share of the CEW.
The reason for this ultra-skew to the very top lies in the subtle and convoluted manner in which monetary inflation deforms the financial markets. What happens is that cheap credit and market-pegging actions by the central bank foster an irregular and syncopated path of financial asset inflation. This bumpy rise is punctuated by sudden windfall gains in stocks and other risk assets which occur with increasing scale and frequency.
These windfalls are heavily “event” driven, as in the case of 75 percent M&A takeover premiums, corporate announcements of giant stock buyback programs, and the huge short-term price ramps that periodically occur among so-called growth stocks. By providing opportunities for outsized rewards to agile traders, as distinguished from fundamental investors, such event driven windfalls recruit more and more speculators to the craps tables.
During the first Greenspan bubble, these storied windfall events and episodes arose initially from the tech sector, such as when Cisco’s stock hit its red-hot stage and witnessed a $350 billion market cap gain in just eight months. In like manner, Intel once gained $250 billion in only four months; the stock price of JDS Uniphase tripled in three months; and, of course, tech IPOs were even more spectacular. Beginning with Netscape’s $14 to $78 per share ramp on August 9, 1995, these tech IPOs often produced massive gains in a single day.
Moreover, while the 10X stock price gains in deal companies like Time Warner, Lucent, and Enron required a slightly greater time frame to unfold, they, too, embodied the principle of rocket-ship gains. So the turbulent financial asset markets which were endemic to the Fed’s money-printing campaigns fostered a growing posse of financial storm riders.
In the fullness of time, this posse became an enormous swarm. The Greenspan Fed thus fostered the mother of all malinvestments; namely, the massive array of hedge funds, private equity firms, highly leveraged real estate partnerships and like venues that flourished around and about Wall Street and came to constitute the fast money trading complex.
These financial vehicles were pleased to call themselves “investment” partnerships, but their game was speculative trading, frequently with leverage in all its forms. They pursued numerous strategies and techniques, but the common denominator was foraging in a financial arena that offered outsized returns based on inside information.
To be clear, the implication is not that the fast money trading complex was involved in something illegal, such as trading based on the foggy concept of corporate inside information of the type proscribed by the SEC. Rather, the “inside information” at issue here was mainly legal; it was inside knowledge of what the Wall Street wise guys were chasing as the flavor of the week, or day, or sometimes even the hour.
Stated differently, lightning fast triple-digit stock price gains or sudden $100 billion market cap demolitions do not happen much on the free market in response to fundamental investment research. In fact, genuine value-changing information capable of causing violent price movements can only rarely be kept secret and sprung on the market without warning; it is the vast exception, not the rule.
By contrast, the stock market “rips” and “wrecks” that became chronic during the Greenspan era were signs that the financial system had been corrupted and deformed by a régime of credit inflation and easy money. After all, what causes asset prices to rise like greased lightning or plunge like a hot knife through butter is the whispered tips of speculators. And easy credit and an accommodative central bank are the mother’s milk of speculation. By David Stockman.
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